QSPS – World's largest Green SRI sukuk
In October 2017, QSPS issued M$1bn of limited-recourse sukuk for the financing of three separate 50MWac solar plants in Malaysia. By Eric Ho, associate director,CIMB Investment Bank Berhad, and Celynna Wong, chief financial officer, ITRAMAS Corporation Sdn Bhd.
Although uncommon in other parts of the world, fixed income instruments, including sukuk, have traditionally been issued to finance infrastructure projects in Malaysia. The uniqueness of the sukuk market in Malaysia is that domestic investors are thoroughly prepared to invest in greenfield projects. The well-established project sukuk market, depth of liquidity provided by the domestic investors and the long tenors available means that project sukuk are the financing instrument of choice for independent power producer (IPPs).
As the Malaysia government targets to increase the percentage of renewable energy in its generation mix, we have witnessed a wave of solar power projects being awarded. The largest of these is led by ITRAMAS Technology Sdn Bhd (ITRAMAS), the lead sponsor of a local consortium, which signed three separate power purchase agreements (PPAs) of 50MWac each in November 2016. Subsequent to the award, the ITRAMAS-led consortium entered into a fixed-sum engineering, procurement and construction contract with Scatec Solar, a Norwegian based Solar IPP, to develop the project.
To tap into the established project bond market in Malaysia, Quantum Solar Park (Semenanjung) Sdn Bhd (QSPS) was incorporated as the funding vehicle for all three projects. This article shares some of the unique aspects of the project.
In October 2017, QSPS issued M$1bn of limited-recourse sukuk for the financing of three separate 50MWac solar plants in Malaysia. This transaction is notable for being the first large-scale solar power plant (SPP) to be financed on a portfolio basis in Malaysia, as well as being the largest Green SRI sukuk issue globally.
The project consists of three solar photovoltaic (PV) plants of 50MWac each in Peninsular Malaysia, located in the states of Kedah, Terengganu and Melaka. Each of the plants would be governed by a PPA signed with three QSPS wholly owned special purpose vehicles – Quantum Solar Park (Kedah) Sdn Bhd, Quantum Solar Park (Terengganu) Sdn Bhd, and Quantum Solar Park (Melaka) Sdn Bhd.
QSPS appointed CIMB Investment Bank Bhd (CIMB) as the financial and principal adviser for the sukuk financing. CIMB and Maybank Investment Bank Berhad were the joint lead arrangers and joint lead managers for the financing.
Following receipt of a conditional letter of award from the Energy Commission (EC) of Malaysia in August 2016, CIMB as financial adviser worked closely with ITRAMAS and QSPS to develop the projects. The result – an unprecedented awarding by EC of three separate solar PPAs to the sponsors within a span of three months and an inaugural solar PPA with Tenaga Nasional Berhad. With the signing of these three PPAs, QSPS will become the largest solar power producer in Malaysia when the plants are operational.
With each project costing about M$400m, the key challenge faced by QSPS and CIMB concerned the tranching of the sukuk financing so as to generate the optimal returns to the sponsors, while concurrently having a suitable tranche size that would garner sufficient interests from sukuk investors.
An 18 year tenor with a semi-annual repayment profile would allow the sponsors to stretch the financing and achieve their target returns. However, this would result in a tranche size of between M$6m and M$12m for each SPP. The scale of this issuance would not be able to generate sufficient interest from investors to create the requisite pricing tension. To overcome this, a decision was made to fund all three SPPs on a portfolio basis. QSPS, a funding vehicle, was set up to issue the sukuk and on-lend the proceeds to each of the SPPs. The combined project cost is in the region of M$1.25bn, which creates sufficient scale to attract investors.
Second, investors in Malaysia were not familiar with the risk profiles of solar plants. This was one of the first and by far the largest SPPs to raise funds from the sukuk market. The challenge was further compounded as the local rating agencies had only recently developed their rating methodology for solar plants.
As such, the challenge was to educate the investors and to assure the rating agencies that the risk allocation of the projects is appropriate. Extensive discussions were held between the rating agency, the lenders’ technical advisers and the sponsors to address any technical concerns on the project. In addition, prior to issuance, QSP engaged in investor briefings and a roadshow to educate investors on the underlying risk of this project.The second challenge was that this was one of the first and by far the largest SPP to raise funds from the sukuk market.
Understanding and addressing the risks associated with uncertainty around the solar irradiance estimates was vital. The PPA contains customary provisions prevalent in all other IPPs in Malaysia. The key difference lies in the payment mechanisms under the PPA.
Payments in IPP PPAs are based on both availability of the plant and the amount of energy generated by the plant. The PPA for the SPPs, on the other hand, is based on purely actual energy generated. As such, both the rating agencies and the sukuk investors needed to be assured on the certainty of cashflows, and in particular, the irradiance studies and factors that affect irradiance such as haze.
This was mitigated by extensive energy yield analysis that incorporated sufficient modelling of data uncertainty using high quality satellite meteorological data. To arrive at the energy production estimates, data for solar resource or irradiation, known as Global Horizontal Irradiation (GHI), collected at the SPP site was adjusted for panel tilt, plant system losses/de-rating factors and uncertainty surrounding the ability to predict the solar energy (irradiance).
There are uncertainties inherent in estimating energy production and as a result, the financial projections for the SPPs are modelled based on probability distributions that are denoted in P-numbers. The cashflow projections were done based on P90 GHI values, indicating that in any given year there is a 90% probability the value will be exceeded. The information collated was used to assure investors on cashflow certainties.
The project contractual structure is customary for projects of similar nature and is as depicted in Figure 1.
The sukuk issue was structured as a sukuk murabahah – an Islamic financing structure well tested and understood by the Malaysian Securities Commission (SC) and the local investor base. Notwithstanding a number of innovative features not previously seen in the Malaysian market, as well as being the first SPP to be rated by Malaysia Rating Corporation Berhad (MARC), the sukuk murabahah was awarded an AA– rating, reflecting the project’s strong credit profile, robust mitigants to residual risks in the structure and the exceptional track record and execution capability of the sponsors. The structure set a new benchmark for AA– rated Malaysian project bonds, paving the way for future SPPs in financings in the Malaysian market.
In addition, the sukuk issue was also the largest Green Sustainable and Responsible Investment (SRI) sukuk transaction in the world. The SRI sukuk framework was development by the Malaysian Securities Commission in 2014 with the objective of growing awareness of investors toward ethically and socially responsible investment and the stricter capital requirements for the bank to finance infrastructural projects.
Some of the key features unique to this financing include:
* Portfolio based financing– Despite being the first SPP rated by MARC, QSPS was able to broaden its reach to a wider spectrum of sukuk investors by combining the funding requirement of all three IPPs and raising funding on a portfolio basis. This has also diversified the risk to the investors as the source of payment from energy generation is now from three SPPs.
* Back-ended equity structure– While the injection of the equity is backed by a bank guarantee provided by the sponsors, this represents the first transaction where bond investors in Malaysia have allowed equity to be injected after the full utilisation of the sukuk murabahah. This has allowed sponsors to utilise the sukuk proceeds more efficiently, thereby resulting in higher returns.
* Green sukuk– The projects were awarded dark green certification, the highest level of green certification, by CICERO. This highest grading entails zero emission solutions and a governance structure that integrate environmental concerns into all activities.
Conclusion and outlook
This transaction has demonstrated that with the right structuring, sukuk investors are willing to consider and invest in pioneering transactions. QSPS has become a pathfinder for the next wave of SPPs in Malaysia. It is also apparent that solar projects are bankable and are increasingly accepted by the capital market as well as gaining interest among investors.
With the successful issuance, investors now have a deeper understanding of risk allocation of the solar projects and have established confidence in the viability of such projects. This paves the way for future growth in green financing and reinforces Malaysia’s status as a market leader in sukuk.